President Joe Biden’s long-awaited announcement on student loan forgiveness and deferment will have a positive financial impact on millions of borrowers. But the credit implications may be harder to understand.
Roughly 60% of U.S. adults have had a student loan on pause due to the CARES Act and other relief policies. Whether you qualify for loan forgiveness or not, the loan pause has likely improved your credit history, and you may see even more benefits in the future.
How Does the Student Loan Pause Impact My Credit?
Student loans will remain on pause through December 31, 2022. Whether you were current on your loan payments before the pause, had a loan in default, or hadn’t started your repayment yet, this can be good news for your credit.
If Your Loan Was in Good Standing
Under normal conditions, federal student loans impact your credit the same way as other loans. Your credit scores improve when you make monthly payments and pay down your balances. But missing just one payment can have a negative impact that lasts for years.
“For borrowers to protect their credit scores, the most important thing that a borrower can do is keep their payments up to date and avoid delinquency and default,” says Jessica Thompson, vice president of The Institute for College Access & Success (TICAS).
Fortunately, the suspended federal loan payments are being reported as “on-time” payments to the credit bureaus. That means the deferment shouldn’t negatively impact your scores.
However, it’s worth checking your credit reports to ensure your servicer reports your on-time payments correctly during the pause. To check all three of your credit reports for free once a week until the end of 2022, you can use the federally authorized AnnualCreditReport.com.
If Your Loan Was in Default
According to the Department of Education, almost 7.5 million borrowers defaulted on their federal student loans in May 2022. The Department of Education hasn’t taken any action to collect these past-due debts since the beginning of the deferment, and borrowers may even have the opportunity to clean up their credit.
Through the department’s Fresh Start initiative, borrowers can rehabilitate their loans and change their credit history to show the loans as “current” rather than “in collections.” Fresh Start will continue for one year after the federal payment pause ends.
The impact of removing a collection account from your credit report will be different for each borrower, but if you have several loans in collections or you have loans that went to collections more recently, rehabilitation could significantly increase your credit scores.
How Would Student Loan Forgiveness Impact My Credit?
So far, it’s unclear how Biden’s student loan forgiveness will impact consumer credit scores, but it’s likely to give many borrowers a boost.
One way loan forgiveness can help is by reducing the overall debt shown on your credit reports.
Debt balances are the second most significant factor in your credit score calculation, accounting for nearly a third of your total FICO score. As your loan and credit card balances go down, your scores typically improve (all else being equal).
On the other hand, if your total student loan remaining balance is forgiven, the account may be closed. While account closure can cause a drop in your credit scores, it’s often minimal compared to the points you gain from reducing your debt balances.
Who Qualifies for Student Loan Forgiveness?
Biden’s August 24 announcement will impact as many as 43 million borrowers. Here’s what we know so far:
For borrowers earning under $125,000: Those who went to college on Pell Grants are eligible for up to $20,000 in loan forgiveness, and others qualify for up to $10,000.
For undergraduate loans: Payments will be capped at 5% of your monthly income.
Prior to the announcement, the Biden administration had already canceled as much as $32 billion for people who met special conditions, including borrowers who were defrauded by certain academic institutions. He’s also proposed interest rate relief.
Visit StudentAid.gov to find out if you’re eligible for federal student loan forgiveness.
3 Tips for Federal Student Loan Borrowers
The federal student loan pause is automatic, so borrowers in deferment don’t have to take any action to extend their loan pause. In the meantime, here’s some expert advice on how you can keep your loan and your credit in good standing:
1. Pay Attention to Loan Announcements
“Borrowers will want to pay close attention to the news and communications from their servicers on any actions they might need to take,” says Thompson.
Frederick Good, senior vice president of student lending at Citizens Bank, says that staying on top of these announcements can help you keep your finances and credit in order.
“If/when the payment pause ends, borrowers will receive at least 30 days’ notice before payments resume,” he says, “and therefore will have some time to understand how that monthly payment amount fits in their overall budget.”
You can also check for announcements and updates from the Department of Education, which has advised that more information about loan forgiveness is forthcoming, including details on how you can claim the relief.
2. Know Your Loan Status
“It’s important for borrowers to refamiliarize themselves with their current student loan situation before repayment starts,” says Good. He says you should know “how many loans, under what terms, at what rates, and the total monthly payment that will resume.”
Thompson adds that borrowers should confirm who their servicer is and update their contact information by logging in to their StudentAid.gov account. (Note: at publishing time, StudentAid.gov was down due to a surge in traffic.)
3. Work With Your Servicer
“I would encourage borrowers to gather information about their loan servicer and become familiar with available repayment plans,” says Karen McCarthy, vice president for public policy and federal relations at the National Association of Student Financial Aid Administrators (NASFAA).
Even if you qualify for forgiveness, you may have some remaining debt. If so, Thompson advises reaching out to your servicer to see if you’re in the best repayment plan available and, if needed, taking steps to reapply.